Regulators to Call for Banks to Have Year's Worth of Liquidity
April 25 2016 - 7:30PM
Dow Jones News
WASHINGTON—Large U.S. banks would have to prove they have enough
cash to withstand severe market turmoil lasting as long as a year
under a new rule set to be proposed Tuesday.
The regulation would require about 30 of the country's biggest
banks to adjust their balance sheets, cutting the odds they would
run into the kind of funding crunch that crippled Bear Stearns and
Lehman Brothers in 2008. But critics say it could also crimp banks'
profits by forcing them to devote more resources to low-return
investments or higher-cost sources of cash, and could disrupt
markets by forcing banks to curb their trading in certain types of
instruments or pull back from certain types of loans.
The rule is being crafted by three agencies: the Federal
Reserve, the Federal Deposit Insurance Corp. and the Office of the
Comptroller of the Currency. The FDIC will release details of the
liquidity proposal at its board meeting Tuesday, along with voting
on an unrelated postcrisis rule to rein in incentive-compensation
on Wall Street. That bonus-pay proposal is being prepared by six
regulators and was released last week by one of them, the National
Credit Union Administration.
The core element of the new regulation is the "net stable
funding ratio," or NSFR. This new requirement would force banks to
show they have sufficient "stable funding" to help them endure a
year of extreme duress. The idea is to encourage banks to rely more
on sources such as core deposits and longer-term funding from small
businesses, and less on short-term wholesale funding—which includes
instruments such as repurchase agreements—that help to provide
another way for large banks to get cash.
The question banks are waiting to see answered is whether the
U.S. version of the NSFR will be similar to one suggested by global
regulators two years ago or whether U.S. officials will follow
their pattern of "gold-plating" international rules by imposing
stricter requirements. Banks also fear that regulators won't just
give them numerical benchmarks to meet, but issue detailed rules
prescribing for them what kinds of transactions are needed to meet
those benchmarks.
Critics of the coming rule say they worry that while it might
make banks safer, it could undermine the smooth functioning of
different parts of the financial system by forcing banks to pull
back from sectors where they have traditionally played a major
role—essentially shifting potential liquidity problems from banks
to the broader financial system.
In addition to worries within the industry, "there is
significant fear among even global regulators that maybe this is a
problematic result in terms of undermining market liquidity," said
Karen Shaw Petrou, a managing partner of advisory firm Federal
Financial Analytics Inc.
Some industry observers also warn about a "chilling effect" on
long-term lending such as aircraft, shipping and project finance,
according to a memo by the law firm Shearman & Sterling
assessing the possible impact of the new rule. The regulation would
effectively raise banks' costs of keeping such longer-term assets
on their books to offset more expensive longer-term liabilities,
according to the memo.
The one-year stable-funding requirement was completed in 2014 by
the Basel Committee, and is one of the remaining pieces for U.S.
regulators to complete their version of that global framework.
These regulations are designed to make banks less likely to face
distress to avert a potential collapse. The Basel proposals aren't
binding, but come in the form of recommendations for regulators to
carry out in their own economies.
Many of the rules are aimed at forcing banks to maintain more
capital on their books to ensure they have a buffer to protect
against losses from risks they take. Those have existed for years,
though they have been strengthened since the crisis.
A new layer of postcrisis protections is aimed at ensuring banks
have sufficient liquidity to protect against a sudden funding
crunch, a modern version of a bank run, even if their underlying
balance sheets are healthy. As the financial crisis began to unfold
in 2007, "Many banks—despite meeting the existing capital
requirements—experienced difficulties because they did not manage
their liquidity," according to a document from the Basel Committee
on Banking Supervision, the group of global regulators proposing
the NSFR rule, explaining the rationale behind it.
The first such regulation in place, completed by three main
American bank regulators in September 2014, is called the
"liquidity coverage ratio." That requirement calls on large banks
to hold highly liquid assets such as central bank reserves, and
government and corporate debt, which can be converted into cash
quickly to cover a firm's obligations over a 30-day period.
The new regulation to be proposed Tuesday is aimed at addressing
stresses that could emerge in a bank's balance sheet if a financial
crisis lasts longer than a month.
The NSFR regulation will apply to roughly 30 U.S. banks with $50
billion or more in total consolidated assets on their balance
sheets, excluding client money. But, if past practice is any
indication, U.S. policy makers will likely impose a more-stringent
rule on the eight largest and most complex banks that hold $250
billion or more in assets, including J.P. Morgan Chase & Co.
and Bank of America Corp., while applying a more relaxed standard
to banks that have more than $50 billion in assets but aren't
internationally active.
A spokesman for J.P. Morgan couldn't immediately be reached,
while a spokesman for Bank of America declined to comment.
"This process should result in a regulation that reduces the
probability of banks coming under short-term funding pressures,"
Fed governor Daniel Tarullo said in 2014 speech previewing the
liquidity rules. "Maintaining more stable funding, such as retail
deposits and term funding with maturities of greater than six
months, will help avoid the spiral of fire sales of illiquid assets
that deplete capital and exacerbate market stress."
Write to Donna Borak at donna.borak@wsj.com
(END) Dow Jones Newswires
April 25, 2016 19:15 ET (23:15 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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